What is NCD (Non Convertible Debentures)
Investors are continually looking for new investment avenues, especially in a market where conventional investment instruments and sometimes falter in a volatile market. One such attractive proposition that can help you manage liquidity and risks while offering significant profits are nonconvertible debentures (NCDs).
What is NCD?
Nonconvertible debentures meaning, NCDs are financial vehicles issued by reputed companies for a specified period of time with a guarantee of a fixed interest to investors. Unlike standard debentures, nonconvertible debentures cannot be transformed into equities or company shares.
The company that issues the NCD decides on the interest rates. On maturity, investors receive the principal amount and the interest together. Nonconvertible debentures can be held by individual investors, banking institutions, primary dealers, unincorporated establishments, registered corporate bodies and other bodies incorporated in India.
Companies issuing upcoming non convertible debentures in the market, do so to raise funds from the public. These NCDs can be secured or unsecured. Secured nonconvertible debentures are supported by the issuing company's assets to accomplish the debt responsibility. Hence, if the company fails to pay its investors, they can claim the payment by liquidating the company's assets. On the other hand, unsecured NCDs are ones that are not supported by the company's assets. Thus they hold far higher risk than secured NCDs.
Features of nonconvertible debentures:
Typically, the interest rate of NCDs overs between 10 to 12%. Fixed deposits on the other hands could offer a maximum of 8% returns. Hence, compared to most investment options, NCDs can be lucrative due to its high-interest rates. However, how credit rating agencies grade a company’s NCD can be inversely proportional to the interest, it provides. For instance, a highly rated NCD could provide low-interest rates. But compared to corporate fixed deposits, bank fixed deposits and government bonds that give a maximum of 8% returns; nonconvertible debentures offer returns up to 11%, which makes it an attractive investment instrument.
Pay out options
If you are looking to invest in nonconvertible debentures, you can benefit from a variety of interest pay out options such as on a monthly basis, quarterly, six-monthly or annual basis. Typically, NCDs could mature from 90 days to 20 years. Hence, you have the opportunity and flexibility of choosing short and long-term tenures depending on your investment objectives.
Non convertible debentures are listed on stock exchanges and offer secure withdrawal options. Redeeming your investment from NCDs can be easier than bank fixed deposits, and hence, can be considered as providing better liquidity than FDs.
A company that offers nonconvertible debentures through open issues can be purchased within a specified timeframe. Similarly, NCDs can also be purchased from the stock market. To understand what is ncd in stock market, you may want to look into the open stock market and exchanges for easily tradable NCD options.
Stringent credit rating
NCDs are only authorised to be issued by companies that have good credit ratings. Credit rating agencies rate NCDs and revise ratings regularly.
Things to consider before investing in non convertible debentures
It is critical to understand how NCDs can be vulnerable to risks. These risks could be related to how a company's business is handled and how it utilises its funds. An NCD’s credit rating could take a hit if the company's turnover is impacted negatively. To address the impact, companies then borrow additional funds from banks and lending institutions. This is why it is critical to consider a few points before investing in nonconvertible debentures. These include:
Issuer's credit rating
Opt for a company that has a credit rating of AA and above. The score is a crucial indicator of the company's potential to raise funds from external and internal operations. The rating is also evidence of the company’s sustainability. Credit rating is a valid parameter that can expose the financial position of the company.
It is essential that you conduct background checks on the asset quality of the organisation if you are considering to invest in its nonconvertible debentures. If a company is allocating more than 50% of its entire assets in unsecured loans, it can be a sign to stay away from such companies.
Capital Adequacy Ratio or CAR looks into the company's capital and calculates if it has adequate funding to outlive potential losses. It can be an excellent idea to look into the company you plan on investing to see if it has at least 15% CAR. Alternately, you must also ensure that the company has historically maintained the CAR over a period of time.
Looking to NPAs
A company issuing NCDs must set aside at least 50% of their assets towards Non-Performing Assets or NPAs. This can be an optimistic indicator of the company's asset quality. In the event that the company's quality declines due to bad debts, you may want to take it as a warning.
A company's ability to settle the interest on any of its debts at any given time can be witnessed in its Interest Coverage Ratio or ICR. The ICR of a company reveals how it can handle potential non-payments.
If you belong in the 10% and 20% tax plan, you may find nonconvertible debentures as a lucrative investment option. This is because, if your tax bracket is low you stand to earn more from NCDs.
There is a marked difference between fixed deposits and non convertible debentures. It can be an excellent idea to look into specific factors before selecting an NCD as an investment option. Consider the company's financial health and how it employs its funds if you notice a diversion from its core business; it can be a sign to stay away from the said company. Going through the credit rating of companies can also give you a fair idea of how your investment is secured. For instance, you may want to steer clear from companies that have low ratings but temptingly attractive, high returns. Such propositions could be risky in the long run, especially if the overall financial health of the company is not stable.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.